Several Federal Reserve policy makers said the central bank should be ready to vary the pace of their $85 billion in monthly bond purchases amid a debate over the risks and benefits of further quantitative easing.
The officials “emphasized that the committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved,” according to the minutes of the Federal Open Market Committee’s Jan. 29-30 meeting released today in Washington.
The minutes showed policy makers were divided about the strategy behind Chairman Ben S. Bernanke’s program of buying bonds until there is “substantial” improvement in a U.S. labor market burdened with 7.9% unemployment, with some saying an earlier end to purchases might be needed, and others warning against a premature withdrawal of stimulus.
The FOMC at its January meeting decided to continue buying $45 billion a month of Treasuries and $40 billion in mortgage- debt without setting a limit on the duration or total size of the purchases. Policy makers also affirmed their pledge to keep the target interest rate near zero “at least as long” as unemployment remains above 6.5% and inflation is projected to be no more than 2.5%.
A number of officials said that their evaluation of costs and benefits of the policy “might well lead the Committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred,” according to the minutes.
‘Substantial Improvement’
“Several others argued that the potential costs of reducing or ending asset purchases too soon were also significant, or that asset purchases should continue until a substantial improvement in the labor market outlook had occurred,” the minutes showed. The minutes don’t give the names of officials or specify the precise number holding a given view.
With inflation below their long-term goal of 2%, policy makers are forging ahead with record accommodation to stoke an economy that shrank 0.1% last quarter. The Fed has pushed the benchmark interest rate close to zero and expanded its balance sheet to more than $3 trillion.
The minutes said “many participants” expressed concern about “potential costs and risks arising from further asset purchases.” Several discussed “possible complications” that additional purchases could have as the Fed begins to exit the policy, a few mentioned inflation risks, and some mentioned risks to financial stability.
Large Portfolio
“Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound,” the minutes said. “Others pointed to offsetting factors, and one noted that losses would not impede the effective operation of monetary policy.”
Growth in the world’s largest economy unexpectedly stalled in the last three months of 2012 as inventories grew at a slower pace and military outlays plunged by the most in 40 years.
The FOMC said in a statement after its meeting last month that “growth in economic activity paused in recent months, in large part because of weather-related disruptions and other transitory factors.” The committee predicted the expansion will proceed at a “moderate pace.”
The recovery in housing -- the industry at the heart of the financial crisis last decade -- shows signs of momentum. Builders broke ground last month on the most U.S. single-family homes in more than four years, with starts of one-family homes rising 613,000, up 0.8 percent from December, Commerce Department figures showed today.
Rail Carrier
The housing rebound is spurring companies in other industries, including CSX Corp., the largest East Coast rail carrier. The company estimates 5% to 6% of its volume is “indirectly or directly tied to the housing market,” said Fredrik Eliasson, chief financial officer. “As we see that market continue to recover, we expect to see benefits,” he said during a Feb. 14 conference.
Higher property values and stocks at five-year highs helped push consumer confidence this month to a three-month high. The Thomson Reuters/University of Michigan preliminary index of consumer sentiment climbed to 76.3 this month from 73.8 in January.
Also, claims for jobless benefits plunged in the week ended Feb. 9, showing employers have little need to trim staff as demand improves. Applications for unemployment insurance payments decreased by 27,000 to 341,000, fewer than any of the 49 economists surveyed by Bloomberg projected, according to Labor Department data.
Consumer Spending
The brighter labor picture is helping to underpin consumer spending. Retail sales rose 0.1% in January after 0.5% increases in each of the prior two months, according to Commerce Department data released last week.
At the same time, “with unemployment at almost 8%, we are still far from the fully healthy and vibrant conditions that we would like to see,” Bernanke said last week at a meeting in Moscow of his counterparts from the Group of 20.
The economy will grow 1.8% this year, according to the median estimate in a Bloomberg survey of economists. That will be too weak for much progress in the unemployment rate, which will average 7.7% this year, according to the survey.
Stocks and bond yields have risen on prospects for a continued economic expansion. The Standard & Poor’s 500 Index has increased 6.8% this year, hitting a five-year high of 1,530.94 on Feb. 19. The yield on the 10-year Treasury note fell 0.1%, to 2.01%, at 1:35 p.m. in New York trading. The yield has risen from 1.72% since the Fed announced new bond buying on Sept. 13.
Price Bubbles
While assessing the outlook for growth and unemployment, policy makers are debating the risk unconventional easing may speed up medium-term inflation or create price bubbles for some types of assets. At the current rate of bond purchases, the central bank’s record $3.08 trillion balance sheet will grow this year by $1.02 trillion.
Fed Governor Jeremy Stein said this month some credit markets, including leveraged loans and junk bonds, show signs of potentially excessive risk-taking.
“We are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit,” Stein said in a Feb. 7 speech in St. Louis. He said the central bank may have to consider higher interest rates and changes to its balance sheet policies to respond to imbalances in credit markets.
Financial Stability
“I can imagine situations where it might make sense to enlist monetary policy tools in the pursuit of financial stability,” he said.
The asset purchases could also complicate the central bank’s strategy to return its balance sheet to more normal levels. The Fed in 2007 held less than $900 billion in assets.
Kansas City Fed President Esther George said last week the central bank may trigger instability in financial markets when it starts selling bonds.
The Fed’s plan for selling securities “could be potentially disruptive to markets and market functioning,” George said in a speech at the University of Nebraska-Omaha. “These actions are untested by the Federal Reserve and could cause an unwelcome rise in mortgage interest rates.”
